High–Low Method of cost estimation is a simple technique used in managerial accounting to separate mixed costs into their variable and fixed components.
In this method the highest and lowest activity together with their corresponding costs is identified. The two points i.e. the lowest and the highest are used to derive a cost function in the form of Y = a + bx
Where Y = Total cost
a = Fixed cost
b = Variable Cost
This method is based on an analysis of historical information of costs at different activity levels.
The high-low method finds the equation of the straight line joining the two points corresponding to the highest and lowest activity levels.
What we need to do is to separately identify the fixed and variable cost elements so that each can be predicted for anticipated future activity levels.
To find the fixed cost (a), you need the following important components:
- The highest level of activity and its total cost
- The lowest level of activity and its total cost
The variable cost is then estimated by calculating the average unit cost between the highest and lowest volumes and the fixed and total cost function can then be derived.
HIGH-LOW METHOD OF COST ESTIMATION PROCESS EXPLAINED
Step 1:
- Identify the highest level of activity and its total cost and the lowest level of activity and its total cost.
Step2:
- Calculate the variable cost using the following formula
Step 3:
- Calculate the fixed cost using the following formula
Y = a + (b x)
Total Cost = Fixed Cost + (Variable Cost per Unit × Activity Level)
Rearranging the formula
Fixed Cost = Total Cost − (Variable Cost per Unit × Activity Level)
WORKED EXAMPLE
1.The following information relates to Kavuma Manufacturing Ltd for the first six months of 2024.
| Month | Units Produced | Labor Cost (KSh) |
| January | 50,000 | 600,000 |
| February | 70,000 | 780,000 |
| March | 90,000 | 960,000 |
| April | 65,000 | 740,000 |
| May | 40,000 | 520,000 |
| June | 85,000 | 910,000 |
Required:
i) Using the High–Low Method of cost estimation, determine the cost function of labour cost.
ii) Estimate the labour cost if the firm produces 75,000 units.
iii) Determine the number of units that would be produced if the labour cost is KSh 850,000.
Here is the Solution step by step
Step 1: Identify the highest and lowest activity levels
- Highest units produced: (90,000 units, KSh 960,000 Cost)
- Lowest units produced: (40,000 units, KSh 520,000 Cost)
Step2: Calculate Variable Cost per Unit
Step 3: Calculate Fixed Cost
Fixed cost = Total cost − (Variable cost per unit × Units)
Using the highest activity level:
=960,000−(8.80×90,000)
=960,000−792,000
=KSh 168,000
